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Value Investing: From Graham to Buffett and Beyond – Book Review

I recently finished reading Value Investing: From Graham to Buffett and Beyond by Greenwald, Kahn, Sonkin, and van Biema.

Value Investing From Graham to Buffett and Beyond - Bruce Greenwald - Book Review

For reference, co-author Bruce Greenwald is a professor at Columbia’s Graduate School of Business (the best business school in the world for value investing and the alma mater of both Ben Graham and Warren Buffett) and a preeminent authority on the subject of value investing, and co-author Paul Sonkin is a portfolio manager at Gabelli Funds (famous value investor Mario Gabelli‘s firm).

Of all of the books on value investing that I’ve read, Value Investing: From Graham to Buffett and Beyond definitely gives the most comprehensive review of the topic. I’d classify it as a necessary addition to the bookshelf of any beginning, intermediate, or advanced value investor.

That being said, I think the breadth of the book (and its relatively short length – just under 300 pages) limited the authors’ ability to more adequately explain certain topics (the different methods of valuation, for example) and I didn’t think the profiles of the value investors in Part III were well done at all.

In any case, I give it 4 out of 5 stars.

For those interested, what follows here is a brief summary of the contents of Value Investing (taken from pages 14-16 of the book itself):

Part I: An Introduction to Value Investing

1 – Value Investing: Definitions, Distinctions, Results, Risks, and Principles

2 – Searching for Value: Fish Where the Fish Are

Chapter 2 describes appropriate search strategies for value investors. Just as geologists hunting for oil, gold, or some other precious resource have created models that indicate what type of terrain is most likely to reward their drilling, value investors have methods for identifying areas of potentially rich investment opportunities. We explain why certain types of securities are more likely to be undervalued than the market as a whole, and how these securities can be identified.

Part II: Three Sources of Value

3 – Valuation in Principle, Valuation in Practice

Chapter 3 discusses valuation proper. The book examines the standard approach to valuation – discounted cash flow analysis – and identifies the serious flaws inherent in the application of this method. The book then offers some alternatives originally presented by Graham and Dodd. The first is to put a value on the assets of a company by starting with its financial statements and then adjusting certain assets to reflect their true economic value, which is the cost of reproducing them at current prices. The most obvious candidate for a desirable security is a stock that is selling below the reproduction costs of its current assets – cash, receivables, inventory – after all liabilities have been paid. These are Benjamin Graham’s famous net-net stocks, and although it was easier to find them during the Depression than it is today, such opportunities can occasionally be located.

A second way to calculate the company’s intrinsic value is to examine its stream of earnings over a period of years and to estimated how much the company should earn on average over the course of a business cycle. The figure should correspond to a market-level return on the intrinsic (reproduction) value of the assets. When the earnings repeatedly exceed this norm, the company may have earnings power that supports an intrinsic value higher than its adjusted net worth. These situations are not common, but they are much less rare than Graham’s net-nets. Finally, but only for those rare companies that possess a sustainable competitive advantage, the profitable growth of the firm needs to be incorporated into the valuation.

4 – Valuing the Assets: From Book Value to Reproduction Costs

Chapter 4 provides a more detailed discussion and a real-world example of how a company should be valued on the basis of the reproduction costs of its assets.

5 – Earnings Power Value: Assets Plus Franchise

Chapter 5 represents a method for analyzing the earnings power value. For a company to generate earnings in excess of an average return on its adjusted net worth on a sustainable basis, it must have a franchise, which is a special and defensible competitive advantage. The book explains the economics behind these competitive advantages, shows how to recognize a franchise, and demonstrates how to value the securities in cases where a franchise exists.

6 – A Wonderful Little Franchise: The Earnings Power of WD-40

Chapter 6 applies this analysis to the recent history of a company with a franchise.

7 – Inside Intel: The Value of Growth within the Franchise

Chapter 7 deals with the least reliable ingredient of valuation: the value of growth. Wall Street loves growth, and companies love to grow; this is a match made in heaven. Managers gain recognition and power; they have more positions to fill and can promote generously; budgets expand; corporate jets abound. Growth means a move up in class. The problem is that most growth is not profitable in the crucial sense that there must be money left over after the additional capital required for growth has been compensated. The only profitable growth is growth within the franchise. This is hard to accomplish, and value investing as a discipline tries to inoculate the investor against paying for growth outside the franchise or for franchise growth that may never materialize. For value investors who are determined to buy growth – and who are willing to pay for it – this chapter describes approaches that put growth investing within a value framework and thus help guard against the siren call of profits increasing without end. The framework is the history of Intel as a company and as a potential investment.

8 – Constructing the Portfolio: Risk, Diversification, and Default Strategies

Chapter 8 demonstrates how value investors construct portfolios to reduce risk over and above what is provided by the margin of safety for individual securities. There are times when Mr. Market is so euphoric that he puts a high price on everything he owns. value investors have to be able to just say no and wait until Mr. Market comes to his senses – or better, until he turns so sour and negative that he will part with anything at a bargain price. At the same time, each value investor needs a default position for funds that have not found a value home. The default stance depends on the standards against which the investor is measured and on other circumstances that vary with the situation. The book presents some alternative default strategies.

Part III: Value Investing in Practice – Profiles of Eight Value Investors

In Part III, the book explores the distinctive approaches of eight value investors. Some of them are household names; others are known only to value investing aficionados. For most of them, the books offers one or two live cases to show specifically how they put their methods to work. The authors believe that value investing is a genuine academic discipline, and that it is closely tied to economic and financial theory. But it is also a way to invest real money, and as such, the arguments are tested by results in the market.

9 – Warren Buffett: Investing is Allocating Capital

10 – Mario Gabelli: Discovering and Unlocking the Private Market Value

11 – Glenn Greenberg: Investigate, Concentrate, and – Watch That Basket

12 – Robert H. Heilbrunn: Investing in Investors

13 – Seth Klarman: Distress Sellers, Absent Buyers

14 – Michael Price: Discipline, Patience, Focus, and Power

15 – Walter and Edwin Schloss: Keep It Simple, and Cheap

16 – Paul D. Sonkin: Small Is Beautiful, Especially When It’s Ugly